Dave Grimmond says the proposal is overly generous, but does have merit – though possibly for different reasons to those thought of by Labour

By Dave Grimmond*

The Labour Party’s proposal for the government to pay for the first three years of tertiary education is overly generous, but it does have some merit…… though for different reasons than I imagine was the basis for Labour’s thinking. 

Some have labelled Labour’s proposal as an electoral bribe (for example see this article) but there are some sound economic arguments for government assistance in the provision of tertiary education and indeed these arguments might justify some movement in education policy in the direction suggested by Labour. 

The main argument for government support of tertiary education relates to the “merit” good nature of tertiary education.  That is, the nation as a whole benefits from having a workforce with the skills acquired from tertiary education.  The biggest beneficiary from tertiary education accrues to the graduates; their career and income prospects are considerably advanced by their qualifications.  But the rest of society also benefits.  We all benefit from having access to doctors, electricians, teachers, lawyers, pharmacists, and so on.  The argument for government support is therefore based on a view that as graduates do not capture all of the benefit from their higher education, there is likely to be less investment in higher education than is socially optimal. 

Such arguments are the basis for “some” government support, not necessarily a blanket full subsidisation of tertiary education.  As most of the benefit from higher education goes directly to the graduates themselves, full subsidisation of tertiary effectively represents a redistribution of income. 

The emotive view is that this is a regressive redistribution, ie the subsidisation of those with better prospects by those with worse prospects.  In fact the issue is more one of fiscal churn and missed opportunities to support those with greater need.  The non-fee component of tertiary education is paid by taxpayers, the greatest proportion of which is paid by the highest earning segments of society.  Lower subsidisation of tertiary education would allow either a lower tax burden or a redirection of government spending towards more “deserving” activities. 

A lower tax burden would typically be expected to more directly benefit the richer segments of society; as the rich typically pay the majority of taxes, they will benefit more from a reduction in the tax burden.  Thus a large degree of the redistribution is actually between generations; from the rich middle aged to the generation of their children.  But if a large proportion of the government support of tertiary education represents the taxing of the rich to pay for the education of their children, then the reduction of this churn would still be expected to generate efficiency benefits (for example, lower tax rates would induce lower economic distortions). 

The alternative to lower taxes is a redirection of government spending.  The criticism of spending more public money on tertiary education is that one is spending public money on the group who have already done well at school and already have greater lifetime prospects.  Spending public money on early childhood activities might be expected to yield higher social returns than fully funding later-life tertiary education.  The argument goes as follows:

  • Children in their first years of life are the most vulnerable to the long term damaging consequences of deprivation.
  • The early years are critical for optimal child development and the realisation of the child’s full potential as a socially engaged, well-educated and trained adult, contributing to national social and economic life at their full potential. 
  • Deprivation impacts upon child development through the inability to access needed goods and services (including healthcare); through disruption and stress of family life; and through social alienation.
  • Effective public investment in the early years of childhood produces measurable improvements in lifetime outcomes for children.
  • Resulting reductions in the demand for remedial government services (education, health, criminal justice) and improvements in labour productivity mean that effective public investment in the early years of childhood represents a sound form of public investment.

The young adults who make it to University are already well on the road to lifetime success, so probably need little further assistance from the government.  But at younger ages, there are still many opportunities for well targeted and well-designed government assistance to make a fundamental difference in the prospects of many individuals.

However, these arguments do not mean that there is no merit in the Labour Party proposal.  The ability to finance tertiary education can still be a critical constraint for prospective students.  One might expect that finance should not be a binding constraint to tertiary students as, even without government support, students’ better lifetime prospects would make them worthwhile financing prospects for banks.  However, not all first year students succeed and banks face some difficulty in assessing which students are better prospects for financial support. 

The way around this adopted by the New Zealand Government has been to take over the banking systems role and provide student financing services directly.  But it is a moot point whether being a lending agency is either an appropriate or effective use of government funds. 

At heart there seems to be a number of competing issues that require resolving in the most efficient manner:

  • Encouraging able students to enrol and work towards tertiary qualifications (social return from an educated workforce)
  • Freeing up public resources to be invested in higher returning activities such as early childhood interventions
  • Providing the private sector banking system with more information about the education and career prospects of individual students (so reducing the requirement for government funded student loans)

Accepting that it is probably impossible to design the perfect policy for financing tertiary education (particularly in a brief article), I present below an amended version of Labour’s proposal that might provide a mechanism of addressing these objectives:

Provide full government funding for just the first year of tertiary education – thus reducing the financial hurdle of initial access to tertiary education, but then freeing up public resources for other activities by reducing the extent of the public subsidy for subsequent years of tertiary education and privatising the management of student loans.

This proposal assumes that government assistance to tertiary education is about human capital development and that education for consumption purposes should be largely privately. Under this system the onus is on students to perform well in their first year of study so that they can demonstrate to banks that they are a good credit risk.  A potential bonus side effect is that the one year of full public funding will encourage an increase in one year tertiary qualifications and so perhaps induce some improvement in the efficiency of the provision of tertiary qualifications.


David Grimmond is an Associate Economist at Infometrics. You can contact him here »